Unraveling the Spin on the Fight Over Hidden Debit Card Fees

What's the case for and against regulation?

We’ve noted that the Federal Reserve and the banking industry have made opposing claims [1] about whether debit interchange fees—the fees that merchants pass on to banks whenever a customer uses a debit card to pay—are on the rise.

The Fed has proposed capping the fees for big banks. But to hear the banks explain it, the rules aren’t needed because fee rates have barely risen. Each side has trotted out numbers supporting its stance. Lawmakers are on the verge of voting on legislation that would delay the rules for further study. But what are the facts? Here’s our attempt to cut through the spin.

Are debit interchange fee rates rising?

Yes. Banks, payment networks and the Federal Reserve [2] all acknowledge that debit interchange fee rates have risen. That’s partly why the banks’ claim [3] that “merchant fee rates are not going up” is so misleading [1]—you have to read carefully and realize that “merchant” fees don’t refer to either debit interchange fees or credit interchange fees alone, but blended together.

As we’ve noted [1], both credit and debit interchange fee rates have been rising—it’s just a question of how much.

OK, so how much are they rising?

Fee rates have stayed fairly level for transactions in which debit cards are used sort of like credit cards—where you sign for a transaction rather than enter your PIN. Called signature debit [4], the fees for this transaction rose in the early 2000s and dipped briefly in 2003 when Visa and MasterCard settled an antitrust lawsuit [5] with the Justice Department on interchange fees. Rates are slightly higher now than they were in 1996.

But debit fees for transactions where you enter your PIN number have risen much more. Those fees have increased dramatically from the mid-90s until about 2005, after which they rose more incrementally. (Figure 2 in a 2009 Fed paper [6] [PDF] shows PIN and signature debit transactions both growing, with PIN transactions accounting for just over a third of debit transactions in 2007.)

Data from the Kansas City Federal Reserve, for instance, show that the interchange fee for a $50 PIN-debit transaction at a small retailer tripled from 2000 to 2010 for Visa, going from 20 cents to 67.5 cents. It quadrupled in the same time period for MasterCard, going from 9.5 cents to 60 cents. Take a look at the graphic below:

Where does the spin come in?

Both sides have used data to argue their cases. The Federal Reserve takes the long view when it points out that interchange fees rates are rising.

Others look just at the rate trends for just the past few years. Take Visa’s debit interchange fact sheet [7], which points out that “between 2006 and 2010, the average debit interchange rate grew less than 1.6%.”

The American Bankers Association takes a similar view. When I asked spokesman Peter Garuccio last week [1] about some of the ABA’s interchange claims, he said that debit interchange fees rates had not “dramatically risen.”

“The changes you get really depend upon what period of time you want to look at,” said David Evans, a former Visa adviser who currently runs a consulting firm [8]catering to the financial services industry. “If you want to look at it from mid-90s, the story is that PIN debit rates went up. If you want to talk about what’s happened in last 5, 6 years, that’s a different story.”

So, if fees haven’t risen that dramatically in the past few years, why are merchants kicking up a fuss?

Merchants are upset because of the debit interchange rate increases, it’s true.

But especially as debit cards grow in popularity, increased debit use—compounded with rising rates—means they’re handing over more and more in fees to the banks. This cuts into their profit margins and/or forces them to raise prices.

No one—not the banks, not the payment networks, not the Fed—disputes this.

Garuccio of the American Bankers Association takes issue with the disproportionate focus on how the changes in interchange fees affect small retailers, when most transactions take place at large retailers that typically pay lower rates.

But according to proponents of interchange regulation [9], that’s exactly the point. “The smallest retailers pay the highest fees,” a spokesman for the National Association of Convenience Stores told the Washington Post.

What’s the case for and against regulation?

Experts such as Adam Levitin of Georgetown Law have noted that interchange rates in the United States are “much, much higher than anywhere else in the developed world.”

As Bloomberg has reported [10], the Fed’s plan would bring U.S. debit interchange rates closer to the rates in other countries, including Australia and members of the European Union [11]. In Europe, both MasterCard and Visa agreed to cap debit interchange fees at 0.2 percent last year—almost six times [12] the average rate in the United States.

But those opposing the Fed’s proposed regulation of debit interchange fees have touted the ways merchants have benefitted from debit cards, such as more efficient transactions and fraud protection.

“The rates are certainly not unreasonable for what the merchants are getting out of it,” said Evans, the former Visa adviser. “What they want is all the benefits of the debit card without having to pay for it.”

So, are there going to be caps on the fees, or not?

It’s looking increasingly likely that the proposed caps will be put on the backburner.

Meanwhile, banks—as well as conservative and libertarian groups [14]—have flooded the Fed with letters and lobbied lawmakers to pass legislation that would delay the rules for further study.

This effort seems to be gaining traction, as Rep. Barney Frank—who sponsored the financial reform law that mandates the interchange rules—announced last week [15] that he supports delaying it. Lawmakers have said they believe they have the votes [16] to pass legislation for a delay.

As Simon Johnson, former chief economist at the International Monetary Fund, noted, that doesn’t bode well for the future of such regulation: “In Washington, the best way to kill something is to study it further,” he wrote [11] on the Times’ Economix blog.

Fed Chairman Ben Bernanke has acknowledged [17] that the Fed would miss the deadline mandated by Dodd-Frank for finalizing the rules, though he said the agency aims to meet its July deadline for implementing them.